Chapter 3: Supply, Demand, and the Market Process

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Course Code
ECO 2013
Joseph Calhoun

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Chapter 3: Supply, Demand, and the Market Process I. Consumer Choice and the Law of Demand a. Law of demand- a principle that states there is an inverse relationship between the price of a good and the quantity of it buyers are willing to purchase. As the price of a good increases, consumers will wish to purchase less of it. As the price decreases, consumers will wish to purchase more of it b. When the price increases, we look for: i. Substitutes- goods that perform similar functions c. The Market Demand Schedule i. Demand schedule- simply a table listing the various quantities of something consumers are willing to purchase at different prices ii. the plotted line is called the “demand curve” 1. y-axis: price 2. x-axis: demand iii. because the amount a consumer is willing to pay for a good is directly related to the good’s value to them, the demand curve indicates the marginal benefit (or value) consumers receive from additional units d. Consumer Surplus i. Consumer surplus- the difference between the maximum price consumers are willing to pay and the price they actually pay. It is the net gain derived by the buyers of the good ii. The height of the demand curve measures how much buyers in the market value each unit of the good iii. Price indicates the amount they actually pay iv. The difference between the two – the triangular area below the demand curve but above the price paid – is the measure of the total consumer surplus II. Changes in Demand Versus Changes in Quantity Demanded a. Economists refer to a change in the quantity of a good produced in response solely to a price change as a “change in quantity demanded” i. Shown on demand curve as a movement from one point on the curve to another b. Changes in factors other than a good’s price – such as consumers’ income and the prices of closely related goods – will also influence the decisions of consumers to purchase a good. If one of these other factors changes, the entire demand curve will shift inward/outward. Economists refer to a shift in the demand curve as a “change in demand” c. Some factors that cause a “change in demand” (inward/outward shift): i. A change in consumer income will result in consumers buying less or more of a product at all possible prices 1. Increase in demand- outward shift on demand schedule 2. Decrease in demand- inward shift on demand schedule ii. Changes in the number of consumers in the market 1. Businesses that sell in college towns are greatly saddened when the summer arrives (e.g. less pizza and beer sales) iii. Changes in price of a related good 1. As gasoline prices rise, increased demand for gas-electric hybrid cars 2. Complements- products that are usually consumed jointly. A decrease in the price of one will cause an increase in demand for the other (e.g. peanut butter and jelly) a. Lower prices for DVD players in the past decade have substantially increased the demand for movies on DVD iv. Changes in expectations 1. If you expect a hurricane to hit, you’ll have a higher demand for canned goods 2. Or “I’ll wait until it goes on sale”  current demand will drop v. Demographic changes 1. Population trends in age, gender, race and other factors can increase/decrease demand for specific goods a. Increased demand for iPods  decreased demand for wristwatches vi. Changes in consumer tastes and preferences 1. People change, preferences change and therefore demand changes III. Producer Choice and the Law of Supply a. What influences the choices of consumers? Producers convert resources into goods and services by doing the following: i. Organizing productive inputs and resources, like land, labor, capital, natural resources, and intermediate goods ii. Transforming and combining these inputs into goods and services; and iii. Selling the final products to consumers b. Opportunity cost of production- the total economic cost of producing a good/service. The cost component includes the opportunity cost of all the resources, including those owned by the firm. The opportunity cost is equal to the value of the production of other goods sacrificed as a result of producing the good c. The opportunity cost of the assets owned by the firm is the earnings these assets could have generated if they were used in another way d. The Role of Profits and Losses i. Profits- an excess of sales revenue relative to the opportunity cost of production. The cost component includes the opportunity cost of all resources, including those owned by the firm. Therefore, profit accrues only when the value of the good produced is greater than the value of the resources used for its production ii. The willingness of consumers to pay a price greater than a good’s opportunity cost indicates that they value the good more than other things that could have
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